Since the introduction of Hong Kong’s formal transfer pricing regime in 2018, taxpayers have navigated a landscape shaped by OECD-aligned principles alongside local regulatory requirements. As we approach another tax filing compliance cycle, it is timely to revisit the transfer pricing documentation requirements, particularly the preparation of the Master File and Local File, and to highlight common pitfalls taxpayers may overlook.

 

Offshore transactions 

A common misconception is that offshore transactions are exempt from Hong Kong’s transfer pricing rules and documentation requirements. In reality, the offshore nature of a transaction does not exempt it from scrutiny. The Hong Kong Inland Revenue Department (“IRD”) is increasingly vigilant in assessing taxpayers’ offshore claims, considering the full facts and circumstances to determine their validity. 

Transfer pricing documentation, especially the Master File and Local File, is key for the IRD when evaluating offshore claims. Transfer pricing documentation provides critical insights into where and how value is created through economic activities performed across jurisdictions. Furthermore, other tax jurisdictions may question whether these transactions are conducted on an arm’s length basis, potentially triggering international information exchange requests. Taxpayers must therefore ensure their transfer pricing documentation is consistent and complete, as any discrepancies could undermine the credibility of both the offshore claim and the transfer pricing position.

 

Financial transactions

Financial transactions, including intercompany loans, guarantees, cash pooling, are another category of transactions that have been explicitly covered under Hong Kong’s transfer pricing regime and must be documented if thresholds are exceeded. Some common areas of oversight include -

  • Using group-wide interest rates without proper justification, or failing to consider credit ratings, market conditions and borrower circumstances.
  • Excluding loan principal from threshold assessments during the year of drawdown or renewal. It is worth noting that both loan principal and interest income or expenses must be included in assessing whether the thresholds have been exceeded during the year of drawdown or renewal.

We have observed IRD enquiries challenging taxpayers’ declarations that thresholds for preparing Master File and Local File have not been exceeded.

 

Domestic transactions 

Taxpayers often assume that all domestic transactions between associated entities are automatically excluded from transfer pricing documentation. However, only “specified domestic transactions” are exempt, subject to specific criteria, most notably the “no actual tax difference” condition or the “non-business loan” condition.  

Example

HK Co A provides marketing services to its related party HK Co B which distributes products outside Hong Kong. If profits accruing to HK Co B are not derived from Hong Kong and are not chargeable to Profits Tax, the no actual tax difference condition is not met. 

In practice, the IRD has raised enquiries on domestic transactions, requesting explanations from taxpayers.  

 

It is the arm’s length amount that should be aggregated

Transfer pricing rules require using the arm’s length amount of each controlled transaction when assessing whether a taxpayer has exceeded the threshold and need to prepare transfer pricing documentation. This means taxpayers must determine and apply appropriate transfer pricing methods before assessing their eligibility for exemption from transfer pricing documentation requirements.

Taxpayers should note that unless the transaction values have been analysed and confirmed compliant with the arm’s length principle, concluding exemption from transfer pricing documentation preparation may be incorrect. Non-compliance could result in a fine of HKD50,000 upon conviction by the court for failing to prepare the Master File and Local File. Failure to comply with the court order may lead to an additional fine of HKD100,000 upon conviction.

 

The arm’s length principle still applies even If documentation preparation is exempt

The IRD expects all related-party transactions to be priced at arm’s length, regardless of documentation thresholds. Taxpayers should reassess their transfer pricing position annually, as changes in business scale or structure may affect compliance obligations.

Companies are encouraged to establish clear transfer pricing policies early, even if current thresholds are not met. This ensures readiness for future events such as IPOs, mergers or acquisitions and helps build credibility to attract new investors.

 

Conclusion

As Hong Kong’s transfer pricing regime matures, the IRD is expected to apply stricter scrutiny to the content and quality of transfer pricing documentation. Simply updating the transfer pricing documentation reports may no longer suffice. Taxpayers should reassess their documentation both in breadth and depth to ensure it accurately reflects the company’s current operations and financial realities.

Robust and up-to-date transfer pricing compliance serves as the first line of defense against transfer pricing risks. By taking a more proactive and thorough approach, businesses can better justify their positions and maximise the return on their compliance investments, both in manpower and cost.

If you have questions or need assistance with transfer pricing matters, feel free to get in touch with our specialist:

Vivian Chan
Director, Transfer Pricing